Cash Flow Analysis
Cash flow analysis on Exhibit 1 represents net cash flow calculation using the base assumption. According to this calculation, Nucor would have net present value of $(11.99) million which is a negative value. This negative value on NPV indicates potential unprofitable consequences after implementing SMS’s compact strip production (CSP); therefore, Nucor should not invest in this new technology.
Instead of using the given assumptions, I have set two alternatives for assumption to see how the results are different. While everything being constant, the first scenario (Exhibit 2) assumes the growth rate of price of steel be 7.34% rather than 6.34%. I assumed that the demand of steel may increase if technology keeps improving and the number of companies selling steel products keeps increasing and the higher demand would eventually lead to the higher price. For the similar reason, the second scenario (Exhibit 3) assumes the growth rate of operating costs to be 5.34% instead of 6.34%. Expecting that the technology and learning experience of companies will improve in near future, the operating costs would also decrease. If growth rate of steel price is increased, the NPV would be $57.53 which is a positive value. If growth rate of operating costs is decreased, the NPV would be a positive value of $35.42. In both cases, I would recommend Nucor to adopt CSP because these results show that new technology would bring profits to Nucor.
According o CFO Siege, Nucor used only a few decision criteria to review and assess the viability of this investment. The first question they addressed is “Will it perform technically as advertised?”. The second criterion was to see if Nucor can get the return on assets (ROA) that the vendor has advertised. The last one was to know if Nucor’s previous capital expenditure constrains its ability to be 100% committed to the project under evaluation. While SMS argued that CSP is supposed to lead to labor and energy savings and higher yields that would reduce operating costs below of U.S integrated mills, there is no clear evidence or examination for this argument; therefore, the first criteria is not yet fulfilled and Nucor is not sure about the performance of technology. For the second criteria, Exhibit 1 shows that its year 5 ROA is 30.89%. Since new plants were supposed to achieve 25% ROA within five years of start-up, and its ROA in the Exhibit 1 is higher than 25%, the second criteria is fulfilled. I would suggest Nucor to also consider expected NPV because it would be still hard to conclude that the project will be profitable without any NPV analysis. The first scenario in Exhibit 2 shows that the investment would add more profits to the firm with positive NPV and ROA would still remain higher than 25%.
Risk and Real Options Analysis
Some of the technological and market uncertainties Nucor is facing are technological leapfrogging, resource constraints, pioneering costs, and difficulty of penetration in the high end market. It is uncertain that CSP technology would perform well as advertised by SMS. Nucor also considers resource constraints as a significant financial risk because it already signed the joint venture with Yamato Kogyo. The company concerns that if they took on the thin-slab project now, the two projects would virtually coincide, stretching the company’s financial and managerial resources. It is also not clear that the process is not proven for commercial exploitation. However, even though there is a possibility that other competitors, such as Mannesman-Demag, try to leapfrog Nucor, Nucor still can use 10 to 12 years as a window of opportunity and it would have competitive advantages over others and reap in benefits by that time. Also Nucor might be able to secure a $10-$20 million discount off the $90 million SMS was asking for core machinery and technical support if it decides to be the first adopter. At this point, the option to defer would be probably the best decision that Nucor could make. It is wise decision for Nucor to wait until the expected NPV becomes positive value because it is very unlikely that other firms would be willing to be a pioneering firm.
Based on the results from various analysis, I strongly recommend Nucor to defer the option and wait for now. As described in the cash flow assumption, NPV is a negative value which means this new investment may not be very profitable for now. Other reason to wait is because Nucor is facing resource constraints and already running new project with another company. However, implementing this new technology would greatly help Nucor gain sustainable competitive advantages. Even though it is not clear that the process itself is not proven for commercial exploitation, it would definitely lead Nucor to capture the largest component of US steel segments and gain pioneer advantage. This project also would result in capturing market for automobile which is one of the largest consumers of flat sheet materials. Even if others try to adopt this technology, Nucor would have an advantage over them if it efficiently run plants. Like this, adopting this technology is very attractive option, but need to wait little bit due to potential risks and negative NPV. If one of the scenarios in the first analysis occurs and NPV becomes positive, Nucor definitely need to accept the option because it would eventually bring huge benefits and profits to the firm. If decided to accept, Nucor should keep in mind to create a low-cost culture and implement cost-saving technologies.